Thursday, February 27, 2014

"A Man Cannot Serve Two Masters"-Directors and Breach of Fiduciary Duty

This past weekend, I visited my daughter who is a freshman at Washington University in St. Louis. I had asked if I could possibly attend a law school class at some point during my visit since my daughter had her own undergraduate classes to attend throughout the day.

I knew ahead of time that I would be sitting in on a Corporations Law class but other than that, the topic for that evening's class was a mystery. When the professor reached the lectern, the first words he uttered were "A man cannot serve two masters". He then launched into a two- hour class on fiduciary duty.

Having represented directors in all types of shared ownership communities for many years, I was particularly interested in the topic. After all, volunteer directors don't always have the easiest time when it comes to operating and administering their communities. Professor T discussed the seminal 1944 U.S. Supreme Court case of Bayer v. Beran. He questioned his students as to whether a person can be honest and still breach his or her duty of loyalty to the corporation. In the Bayer case, Mr. Dreyfus, the Chairman of the Board of Celanese Corporation of America, decided that a radio advertising campaign would be great for the company and his wife just happened to be one of the singers on the program in which Celanese would be advertising. While Celanese hired an advertising agency to produce the ad and the advertising commitments were subject to cancellation at any time, some of the company shareholders were still concerned that it was not a fair transaction as they felt that the decision was made simply to advance the spouse's career. A shareholder's derivative action ensued wherein Mr. Dreyfus's loyalty to the company was challenged.

Professor T explained to his class that if a director's actions are challenged, then the burden is on the director to not only prove the good faith of the transaction but also to show the inherent fairness from the viewpoint of both the corporation and those interested therein.

How many times has a director who also owns a business which serves community associations believed that his or her company would do the best job cutting the lawn, cleaning the pool, managing the community, etc.? When questioned about the potential conflict, the director usually says something along the lines of "Well I know my company will do the best job because I live here and will observe the work and will give the best price." Now, this may very well be true and the director's company may be the very best fit for his or her community but it is still up to the other disinterested directors and not the conflicted director to make that decision.

This logic was articulated in the Bayer case which remains good law to this day. The Supreme Court found that the Chairman's wife was actually a very competent singer who had a reasonable rate of pay which made the entire board's decision to advertise on the program reasonable.

Overall, the decision to hire a particular person or company must be fair and in the best interests of the association and not just in the best interest of the director with the connection. Of course, just like Mr. Dreyfus, an association director with this kind of conflict should be prepared to live with the possibility of scrutiny at best and a public relations nightmare at worst.

2 comments:

  1. Donna:
    Believe the most significant issues when dealing with potential conflict are transparency and recusing ones' self when the matter is voted on . When these two principles are practiced the “conflicted” board member has done his/her duty to inform the community and step back from the decision.

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  2. Very good topic, Donna. However, perhaps you should address this topic to state legislatures, like Arizona's, where a director need only declare his conflict of interest and is then allowed to vote on the issue. Unbelievable!

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